Safeguard Magazine

Comment—Too risky to recommend

MANS CARLSSON-SWEENY explains how investment analysts consider health and safety risk as a factor in recommending a company to investors – or not.

Environmental, Social and Governance (ESG) research can uncover hidden investment risks and help investors make better informed decisions. Occupational health and safety is a key aspect of ESG and can have significant impact on investment returns.

To understand how integration of ESG analysis into investment analysis can assist, the starting point is to understand what drives value. Our research shows that for a typical listed company, the majority of a company’s value stems from so-called intangible drivers – that is, aspects you do not necessarily find in a financial statement.

Importantly, analysis shows that the proportion of a company’s value that comes from intangible drivers increases over time. Examples include a company’s supplier and customer relationships, its corporate culture, and its systems and processes for management of key risks, such as health and safety.

While each of these intangible drivers might not always have a significant direct link to earnings, on an accumulated basis they can provide investors with an indication of the quality of a company’s management. In other words, management of key intangible drivers can be a proxy for management quality.

ESG analysis covers a wide range of these non-financial drivers, which may differ in importance for various sectors. However, health and safety is often a key factor. For instance, our review of listed transport companies in Australia and New Zealand concluded that the costs of poor health and safety risk management are rising, both in terms of direct and indirect costs. The latter include a wide range of hidden costs, including reduced staff engagement, loss of productivity, and management distraction. In some cases extremely poor safety performance can even lead to loss of customers, who want to distance themselves for reputational reasons.

While legal costs, workers compensation and other direct costs can be easily quantifiable, it can be more difficult to assess the indirect costs. However our research indicates that as a rule of thumb, the indirect costs are at least as high as the direct costs – and often significantly higher. In addition, poor health and safety can be a key contributor to industrial disputes and, in extreme cases, industrial action, which can have a major negative impact on earnings.

As a result, investors need to do their homework. Good ESG analysis aims to answer two questions: does the ESG issue have an impact on earnings and share prices? And is it factored into the price already?

In an efficient market, where all information is available to all investors, companies’ safety performance would be priced in already. However, due to poor disclosure as well as lack of standardised safety reporting, significant information gaps occur. Companies are increasingly reporting LTIFR and, generally, these rates have improved over time, but they might not tell the full story. For instance, the published safety statistics may ignore severity of injury and can be easily manipulated, which might be a particular risk when linked to executive remuneration. In addition, published data tells the story of past performance on a particular metric, not how a company is managing safety risk.

This became apparent in our analysis of the transport sector. In one case, a company’s LTIFR had fallen steadily over five years – but the number of fatalities had been rising. Also, the statistics only covered full-time staff and ignored contractors who, anecdotally, posed the greatest safety risk. This case highlights how investors need to see beyond what is being reported on safety. Conversations with other stakeholders such as unions and employees can give additional insights. This was a resource that was used for our review of the transport sector. Other indicators to take into account include whether a company has certified health and safety management systems in place, as well as if (and how) safety training is provided for staff. In this particular case, the risk was considered too high; the company received a poor ESG rating and was excluded from the fund’s investible universe.

However, while poor safety risk management might deter investment in some cases, the opposite can be true for companies with strong focus on workplace issues. Our review of listed Australian and New Zealand retailers found examples where improved focus on health and safety risk management had been a contributor to improved staff engagement. This is important, as the same report identified a correlation between staff engagement on the one hand and customer satisfaction on the other. In turn, in a retail industry plagued by structural challenges, strong customer satisfaction can be a major driver for customer loyalty and sales.

ESG analysis, including analysis of a company’s true health and safety risk management, can be time-consuming, but it can help investors detect mispriced securities and avoid major blow-ups before it is too late.